In recent times, public sector banks have been aggressively selling their bad loans to asset reconstruction companies (ARCs) in a bid to reduce their pile of stressed loans. ARCs are formed under Section 3 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act, 2002, to acquire non-performing assets — where the borrower fails to make interest or principal payments for 90 days — from banks and financial institutions.
The idea behind setting up these companies was to help banks manage and recover bad loans. The Debt Tribunal or civil courts present earlier were neither effective nor fast. Which is why ARCs were set up to enable faster recovery without court intervention.
The sudden rush
But sale of bad loans to ARCs only gained momentum in 2013-14. Before that, banks did not use this tool very effectively. So, what led to the sudden rush to sell off assets?
One obvious reason was the sharp jump in the bad loans of public sector banks. The total gross non-performing assets shot up from 2.7 per cent levels four years back, to 4.6 per cent of loans in 2014-15. With tighter norms on reporting and managing of stressed assets, banks have been even more pressured to get their house in order.
ARCs usually offer to take the loan off the banks’ books at a discount. So, for instance, a ₹100-crore loan on the books of the bank, may be valued at ₹50 crore by the ARC. The sale by banks to ARCs can happen in two ways. One, an outright cash purchase, under which the agreed amount (₹50 crore) is paid upfront. Two, where security receipts (SR) are issued. Under this, banks are willing to accept a small portion of the agreed value as upfront cash payment. For the rest, banks are issued SRs, against which payment is made as and when the ARCs recover the loan amount.
In the above case, if the agreed amount is ₹50 crore, then ₹5 crore is paid as cash, and for the balance of ₹45 crore, an SR is issued. Once the loan is recovered, the balance is paid to the bank.
The other reason why banks were willing to sell assets to ARCs was because of the better pricing offered. The significant jump in pricing in 2013-14 happened due to a shift in deals from the cash route to the security receipts (SR) route. From about 30 per cent in the past, ARCs started paying 55-60 per cent of the loan value. This was possible because, instead of taking upfront cash payments, banks were willing to accept delayed payment in the form of SRs. ARCs were thus making a down payment of minimum five per cent and the balance 95 per cent of the loan value agreed on was paid to the bank against the SR.
In 2013-14, close to ₹51,000 crore assets were sold by banks to ARCs, a sharp jump from the ₹10,000 crore they sold the previous year. This was thanks to the better pricing offered to banks.
RBI intervenes
While the substantial increase in sale of bad loans did help banks reduce their stressed assets, the truth was that the better prices came with some strings attached and led to a number of issues. For one, banks stopped recording the assets as bad loans in their books and made no provisions for them. This meant that ARCs sales, just like restructured loans, helped banks evergreen their loan books. Two, such sales happening against SRs did not improve the bank’s cash-flows. Three, banks would have to bear losses from such default.
It was due to such risks that the RBI intervened last August to mandate a minimum cash payment of 15 per cent from ARCs for every asset sale. This has impacted the sale of assets in 2014-15, as a higher upfront payment expected from ARCs dissuaded them from offering a better price. In 2014-15, banks sold ₹50,000 crore of bad loans, a tad lower than what they offloaded a year back.
While this move has impacted the sale of assets, it has also brought in more realistic pricing, which was the intent of the RBI in the first place.
Likely to pick up
With many banks now willing to price their assets more reasonably, sale of assets is likely to gain momentum in the current fiscal. With the window for restructuring going away from April 2015, banks are likely to resort to selling their bad loans to ARCs.
In January 2014, the RBI had allowed losses incurred on sale of assets below the net book value by banks to be amortised over two years. This window was opened until March 2015. The RBI recently extended this leeway for another year. This one-time dispensation may thus boost sales further.
Spruce up recovery process
The ARCs were set up under the Sarfaesi Act, to enable faster recovery without court intervention. But, in reality, judicial interventions and the inefficacy of the Debt Recovery Tribunals (DRTs) are still preventing speedy recovery of dues.
ARCs, when set up, had the right to send a 60-day notice to the borrower asking him to pay the dues, failing which ARCs could take possession of the mortgaged assets. If the borrower had any objection, he could go to the DRT or a High Court to decide the case. The DRT was then supposed to adjudicate the matter within 180 days.
But currently, these cases take a long time, sometimes years, to decide. Most of the time, instead of adjudicating the matter, courts issue a stay order, which delays the process further. Judicial interventions that cause delays in the recovery process of ARCs need to be addressed first.
With more banks selling off bad loans in the coming quarters, the role of ARCs assumes greater importance. It is imperative for these companies to expedite the recovery process if they are to provide any incremental value addition at all.